Growth has fallen in the last couple of years eroding
revenue while inflation remains stubbornly high. The new pay commission will
have to factor in both concerns

Why does the government appoint a pay commission every
decade?

A pay panel is appointed every decade to review and
recommend the pay structure for central government employees taking into
account various factors such as cost of living, inflation rate, revenue growth
and fiscal deficit of the government, growth in workforce, private sector job
scenario and wages, and economic growth. The government has so far appointed
six pay commissions. The demand for a permanent pay commission set up through
an Act of Parliament has been raised once but it was not accepted by the
government.

Earlier this month, Prime Minister Manmohan Singh
approved the constitution of the Seventh Pay Commission—to be headed by retired
Supreme Court judge Ashok Kumar Mathur—to suggest the extent of hike in
salaries of the 7-million-plus central government staff and pensioners with
effect from 2016. Petroleum secretary Vivek Rae has been appointed as a
full-time member, NIPFP director Rathin Roy will be part-time member and Meena
Agarwal will be member-secretary of the new pay panel.

How did the process of pay hikes evolved?

The pay panel recommendations have evolved with time. The
first central pay commission (CPC) adopted the concept of “living wage” to
determine the pay structure of the government staff. The third CPC adopted the
concept of “need-based wage”. The fourth CPC had recommended that the
government constitute a permanent machinery to undertake periodical review of
pay and allowances of its employees, but this was not accepted by the
government. The sixth CPC suggested performance related incentive scheme (PRIS)
to replace the ad hoc bonus and productivity-linked bonus schemes. The pay
panel also suggested that the running pay band be extended to all grades of
officers. Also, the sixth pay panel suggested slashing of the number of grades
to 20 and one distinct pay scale for secretaries from the 35 existing earlier.

By how much have the public sector salaries increased
every decade following the pay panels’ recommendations?

By and large, the salaries of central government staff
have tripled every decade. The sixth CPC suggested 3 times increase in salaries
from that of fifth CPC levels—it was 2.6 times for lower grade officials and
slightly above 3 for higher grade staff. The increase in salary during fifth
CPC was 3-3.5 times the fourth CPC levels.

What has been the fiscal implication of pay hikes?

Government finances have come under strain after
implementations of each CPC. After the fourth CPC, the combined fiscal deficit
of centre and states rose to 9.5% of GDP in FY87 from 7.7% in FY86. The impact
was significantly harsh during the fifth CPC, especially for states—the combined
fiscal deficit rose from 6.1% in FY97 to 7% in FY98 and then to 8.7% in FY99
with the aggregate deficit of states surging from 2.6% to over 4%.

In the case of the sixth CPC, the government expenditure
increased by about Rs 22,000 crore during 2008-09—Rs 15,700 crore on the
general budget and Rs 6,400 crore on the rail budget. The Rs 18,000 crore
arrears were distributed in two years—40% in FY09 and 60% in FY10. The fiscal
implication of sixth CPC coupled with fiscal stimulus in the form of higher spending
and tax cuts after the Lehman crisis, increased Centre’s fiscal deficit to 6%
in FY09 and 6.5% in FY10 from less than 3% in FY08.

What are the challenges before seventh CPC?

The new pay panel faces many challenges when it starts
the process of reviewing the pay structures of babus. First, the economic
growth has slowed sharply in the last 10 years—from over 9% between FY06 and
FY08 to 4.5% in FY13. This means slower revenue growth and little room for
scaling up expenditure on salaries.

Second, the Fiscal Responsibility and Budget Management
(FRBM) target has already been revised more than twice after the Lehman crisis
and the new target for lowering the fiscal deficit target to 3% of GDP is FY17.
This again binds the government to restrict spending on salaries and wages.

Third and the most important factor, inflation has stayed
high in the past few years—the CPI inflation (CPI-Industrial Workers and the
new CPI) has averaged over 9% in the past eight years, which means cost of
living has gone up significantly and hence necessitates higher compensation for
workers. The dearness allowance of government staff has already touched 100%,
which along with the rise in other allowances have more than doubled salaries
since 2006.

Analysts expect the seventh pay panel to suggest 3-3.5
times hike in salaries across various grades from sixth CPC levels apart from a
further rationalisation of government staff. Already, direct or permanent jobs
in public sector have been shrinking while engagement of contract labour and
outsourcing is on the rise. This trend is likely to continue given the fiscal
imperatives of the government.

There is a perception that government salaries should
rise faster at the higher grades and slowly at the lower grades to keep pace
with private sector. It needs to be seen whether the seventh CPC retains the
minimum:maximum ratio at sixth CPC level of 1:12. A hike in the ratio should
not impinge the fisc much as the top level officials—joint secretaries and
above—comprise less than 5% of the overall public sector workforce. The
performance related incentives could also be reviewed to retain talent within
the public sector. More than the fiscal implication, what matters is the
productivity of the public sector. For instance, sluggish clearances needed for
large projects have ruined investment and halved the growth rate in last three
years. The silver-lining of the next CPC could be that it may boost the
services sector growth and help revive the faltering economy from 2016 as
higher salaries boost spending on housing, automobiles and consumer
electronics.